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Uncovering basis shrink: Where are milk check deductions being made?

Progressive Dairyman Editor Dave Natzke Published on 18 December 2017

Milk prices improved somewhat in 2017, but price announcements don’t tell the whole story. Market deductions are cutting into the totals dairy farmers actually receive in their milk checks.

“Basis” continued to shrink for a third straight year in the Upper Midwest No. 30 Federal Milk Marketing Order (FMMO), according to Mark Linzmeier, owner of MarginSmart, a dairy financial and marketing information company headquartered near Green Bay, Wisconsin.

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Mark Linzmeier

For this purpose, basis is the difference between an announced price and the price actually received by the dairy farmer. Historically, the Upper Midwest order has been one of the most competitive for milk. As a result, basis in the region has also been one of the strongest.

With milk processing capacity stretched, and the milk supply-demand balance out of whack, basis is being pressured lower.

Where deductions to basis are being made on producer milk payments are not always clear. Individual dairy farm basis may differ from others’ due to differences related to the dairy plant’s premiums, hauling charges, deductions and other payment factors.

The basis also can differ between farms based on items controlled by the dairy farms themselves – most notably, individual component percentages and somatic cell counts.

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To help producers calculate their basis and unravel sometimes non-transparent milk checks, Linzmeier launched the Smart Milk Basis program earlier this fall at World Dairy Expo. The fee-based program analyzes an individual producer’s milk basis and net mailbox price compared to cohorts within the same federal order. Producers who ship to private and cooperatively owned plants are included in the analysis.

Using the Smart Milk Basis program, Linzmeier has created a peer group involving dairy herds and milk processors in the Upper Midwest FMMO. In the first monthly report, those herds represented 40,000 to 50,000 cows and averaged about 1,200 cows per herd.

To date, Linzmeier has analyzed milk basis data between 2014 through September 2017 and will continue to update analysis going forward.

Information incorporated into the analysis includes component percentages, payment per pound of various components by the farm’s milk plant, FMMO-announced producer price differentials (PPDs) and actual PPDs paid by plants, other market adjustments and premiums, somatic cell count levels, as well as hauling charges, checkoffs and assessments applied against the farm’s net milk price.

Linzmeier has attempted to take some of the “noise” out of the calculations by removing factors outside the control of the processor. Those include differences in actual component percentages, somatic cell counts, changes in FMMO PPDs and the impact of milk contract gains and losses and others.

His goal is to come up with a “net” bottom line in regards to basis to allow a reasonable comparison between dairy plants for dairy farms with equal component percentages and somatic cell counts. In addition, he breaks out various portions of the basis to help dairy farms understand where these differences occur.

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His analysis is also calculated on a weighted (per-hundredweight) rather than a simple (per-herd) average.

Overall decline

Anecdotally, Progressive Dairyman has heard of basis shrinkage approaching $1.50 per hundredweight (cwt) in some parts of the country.

In the Upper Midwest, Linzmeier’s peer group has seen milk basis shrink a cumulative average of 62 cents per cwt (comparing milk of equal component percentages) for the period of January 2014 through September 2017. The year of 2015 saw a basis drop of 33 cents per cwt; 2016 resulted in another decline of 17 cents, with a drop of 12 cents per cwt through the first nine months of 2017.

Taking the analysis further, Linzmeier said the FMMO-announced PPD in 2014 averaged +24 cents per cwt; in 2017, year-to-date averaged +17 cents, so 7 cents of the 62-cent change in basis can be attributed to differences in the announced PPD.

Excluding that 7-cent change in PPD not under control of the individual plant leaves 55 cents per cwt, the amount individual plants can control through PPD payments compared to the announced PPD, component payments compared to the stated component price and premium programs.

With the PPD adjustment, the cumulative basis decline among all co-op and private plants ranged from 42 cents per cwt to 70 cents per cwt over the full period.

Analyzing individual milk checks, Linzmeier worked to determine where basis was being lost. Over the 2014 to September 2017 period, peer group herds (selling milk to both co-op and private plants) have seen:

  • Actual PPDs paid compared to FMMO-announced PPDs shrunk an average of 13 cents per cwt. Most PPD reduction has occurred on the co-op side, with some producer-members seeing a 30 to 50 cent per cwt “disintegration” in the PPD over the entire period. In general, private plants paid the full PPD, although there were some individual instances where PPD was reduced. In some cases, some private plants were overpaying PPDs in 2014 but are no longer doing that.

  • Component prices, especially “other solids.” Another area where deductions were evident included plants not paying the full FMMO price for components. While situations where minor deductions were made to monthly reported FMMO protein and butterfat prices were very infrequent, the overwhelming majority line item where deductions were made was in “other solids.” Again, this was mostly among co-ops, but some private plants were also underpaying on other solids.

Looking at his peer group, underpaying for other solids started in 2015, continued in 2016 and has escalated in 2017. Linzmeier attributed the average impact in his peer group over the 2014 to 2017 period at about 12 cents per cwt. However, individual producers saw markedly higher deductions. Linzmeier reported one co-op member saw the other solids deduction impact on the overall pay price of almost $1 per cwt in selected months.

“That’s a significant difference,” he said. “People don’t think of ‘other solids’ contributing much to the overall price, but when you calculate it out, it can make a huge difference. It was eye-opening to our customers.”

  • Premium adjustments. There have been some differences in how co-op and private plants have reduced basis to cut milk pay prices overall. While co-ops are generally taking basis away through PPD reductions and underpaying on other solids, there also has been some adjustments to premiums.

The scales for this area of deductions are tipped toward private plants, which have resorted more heavily on reductions in volume and quality premiums, Linzmeier said.

Compeer analysis

Matt Lange

Matt Lange, business consultant with Compeer Financial, Baldwin, Wisconsin, also monitors basis and reviews milk checks for his clients in the Upper Midwest.

That group of herds, analyzed monthly under Compeer’s Dairy Consulting Team Benchmark, averages about 1,250 cows, with a total of about 82,000 head.

Like Linzmeier, Lange sees similar practices related to milk checks, especially with underpayment for other solids. With the Upper Midwest emphasis on cheese production, some processors are paying more than the FMMO-announced price for protein but underpaying on butterfat. He has also seen volume premiums reduced or eliminated completely.

Lange cited one other situation when it comes to basis: Two herds, with similar production and quality and marketing milk to the same co-op, but two differing plants, receiving substantially different basis. In one case, one farm received a basis of $1.50 per cwt with the other averaging 9 cents per cwt.

In the Upper Midwest, basis is traditionally higher in November-February and lower at other times of the year, bottoming out in August. As it shrinks in high times, calendar-year basis fluctuations are now flattening out.

Separate from actual milk pay prices, producers are being asked to pick up a greater share of – if not all – hauling costs, Lange said. One independent processor has asked a Compeer producer-client to pay the full hauling costs next year, which will raise his hauling costs from 32-33 cents per cwt to over 80 cents per cwt.

Some co-ops will also be cutting hauling subsidies in 2018, and Lange foresees a time when hauling charges will be based on proximity to a plant.

Transparency differs

Both Linzmeier and Lange say some co-ops have changed the way they are reporting milk check deductions to their producer-members, making it more difficult to determine specifically where deductions are made. For example, one co-op cited by Linzmeier originally made deductions on the PPD line but then began paying the full PPD announced by the federal order while adding a separate “market deduction” line on the milk check.

Lange and Linzmeier have also seen variation in how co-ops communicate those deductions. Program-level changes are generally communicated, such as a change in a volume premium program.

Going back to 2015, some customers said they were notified when a co-op planned to make major adjustments to PPDs and overall pay prices for a defined period, Linzmeier said. However, adjustments to “other solids” are seldom, if ever, communicated. “I’ve had no customers tell me their co-op told them that was going to happen,” he said.

Lange agreed, saying producer communication has been mostly silent when it comes to deductions for other solids.

While analysis from Linzmeier and Lange is focused on the Upper Midwest federal order, Cal Covington, a retired dairy cooperative CEO in the Southeast, said it’s likely almost all co-ops have paid members less than the announced blend price during the past year or more.

Milk check deductions have been made to cover balancing costs to find markets for excess milk that is sold at steep discounts or dumped, as well as cover plant operating costs. A variety of pricing programs – sometimes within the same co-op and in the same marketing area – make reading and understanding milk checks complicated.

In the Northeast, it appears dairy co-ops are moving toward “true” costs of hauling. While individual hauling charges between producers varied widely in the past, hauling costs are now going up 10 to 20 cents per cwt for many producers, according to Gregg McConnell, farm business consultant/large dairy benchmark and dairy profit analyzer with Farm Credit East, Geneva, New York.

Formerly, McConnell said, most co-ops in the region had PPD and location adjustments netted to one-line PPD line on the milk check. More recently, most separate the PPD and location adjustments. While it adds a line on the milk check, the net effect is no change to the producer.

McConnell has seen most premiums typically cut in half in the past six to 12 months.

Read also: Analysis finds wide range in ‘basis’

What’s ahead?

Given the current milk market outlook, Linzmeier projects basis downward pressures to continue over the next 12 months.

“With the amount of milk out there, I won’t be surprised to see it continue in a negative trend until we get some rebalancing in supply and demand. We could see another 10 cents per hundredweight in 2018.”

Within the Upper Midwest FMMO, Linzmeier said he isn’t seeing much competition for milk at this time and doesn’t expect that to change unless something big happens related to supply. Some plants built capacity but filled it much quicker than anticipated.

Why is knowing basis important?

Knowing true basis is important for producers making business decisions based on net income. (See “Account for milk check deductions in your risk management strategy”.)

Linzmeier has been proactive projecting declining basis in his clients’ marketing strategies going back to 2015, adjusting expected basis lower so producers could make management decisions based on an accurate net bottom line. For most customers, MarginSmart factored in a 75-cent-per-cwt reduction in basis over the three-year period.

“Conceptually, when you’re contracting milk, you’re locking in that price. If you didn’t change that and are contracting milk on a 2014 basis, you’re locking in milk that will yield a 62-cent-per-hundredweight (or whatever your specific drop in basis was) hit to your bottom line,” he said.

Some co-ops, Linzmeier said, offer more sophisticated risk management strategies to help producer-members deal with shrinking basis. Most plants, however, don’t have the staff to offer that information.

Lange said shrinking basis has also impacted how he advises clients to estimate net income to manage farm finances. And with the emphasis on protein in a cheese market, Lange urges producers to look closely at their individual basis to see where they are paid. If the financial incentive leans more heavily toward protein, he has recommended considering ration tweaks to boost production of that component.

Processors squeezed too

With an eight-year background in managing profitability for a major beef processing company, Linzmeier said he understands the economic pressures on the plant side.

“Life is not always rosy on the processing side because they have to make things work as well. With all this milk coming at them, and the overall combined domestic and international demand isn’t commensurate, I don’t want to say plants are specifically taking advantage of the farms.”

Under the Capper-Volstead Act and federal order rules, cooperatives are not bound to pay the minimum blend price. The exemption recognizes members share in the co-op’s profits and losses, and there are times when a co-op has financial obligations related to plant expansion or construction, balancing costs or times of the year when a plant is losing money.

“The biggest thing is that the industry needs to get supply and demand more in line,” said Linzmeier. “We won’t see better prices until we see that. Unfortunately, I don’t see that happening on the demand side over the next six to 12 months. So it’s the supply side that is going to have to drive higher prices.”  end mark

PHOTOS: Courtesy photos.

Dave Natzke
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